Marriott Earnings

Mammoth hotel and resort operator Marriott (NYSE:MAR) reported second-quarter earnings of $119 million, or 31 cents per share, 4 cents above internal estimates and triple what the company earned a year ago while revenue ticked up 8% to $2.8 billion. Pushing the earnings surprise was a rebound in demand from the business traveler demographic, and some modest daily rate hikes.

Travelers Slowly Heading Back OutHotel operators began deeply discounting rooms in 2008 as occupancy rates plummeted up to 50% in most major markets. Rates stayed low throughout 2009, and operators either slowed new construction projects or shuttered them completely. This evening out of the supply side has helped push industry-wide occupancy rates back above 60% in 2010, finally giving upper-tier managers like Marriott the chance to start raising prices again without crimping demand.

During the past two years, hotel operators with more budget-minded brands like Choice Hotels International (NYSE:CHH) (Comfort Inn, Econo Lodge, Quality Inn) or Wyndham Worldwide (NYSE:WYN) (Ramada, Days Inn, Super 8) were better able to preserve pricing. But as both leisure and business travelers begin to dust off their suitcases in 2010 and beyond, more of the upscale hotel brands - like Marriot's Ritz-Carlton and Courtyard - should be able to drive strong occupancy gains.

Important Metrics ImprovingThe all-important metric of RevPAR (revenue per available room) rose 9.9% globally at Marriot's company-owned hotels. The company also licenses their brands to franchisees and collects a stable stream of income from fees and incentive payments. Franchise fees rose 13% year-over-year to $287 million, while incentive fees rose 31%.

During boom periods, Marriott will collect incentive fees (triggered by profitability breakpoints) on as many as 70% of franchised locations, but that number currently sits at just 25%. While it could be several years before incentive fees hit the 50% plus level, this fee income shows the kind of powerful operating leverage a high fixed-cost operator like Marriott can achieve when the economy has a clean bill of health.

Targeting Global GrowthWhile new room growth has slowed tremendously in North America the past two years, foreign markets remain strong and are the source of over 40% of Marriot's planned growth. Management plans to more than triple the number of hotels in India by 2013, going from 11 currently to 40. And in China - already Marriot's second-largest market outside the U.S. - 22 hotels are under construction, adding to 47 that are already open.

Marriott is facing stiff competition with other U.S. players to penetrate their brands into these markets, especially Starwood Hotels & Resorts (NYSE:HOT) and Hyatt (NYSE:H). Starwood is a supreme operator in the luxury space and like Marriott has ambitious plans for India and China, but both markets are vastly underserved. In fact, there are nearly as many hotel rooms in New York City alone than in the whole of India.

And despite all the bad news swirling around Europe, travel has actually been a strong point. A weak euro has enticed travelers from North America and Asia to come to Europe for the increased buying power, which boosts local profitability, but it somewhat mitigated by the negative effects of transferring those profits back in to dollars.

Investor's Quick Industry ForecastMarriott was decidedly upbeat in its conference call, but noted that the health of the economy is still the all-important driver. Given Marriot's dependable fee income stream, they should be able to stay profitable even if GDP falls below forecasts for 2010, as some economists have been suggesting lately. In addition, management is hoping to increase rates through the end of 2010 and into 2011. It is currently calling for system-wide RevPar growth of 4-6% for the fiscal year.

The Bottom LineGiven Marriot's rather rich forward P/E of 23-times, investors would be well served to see what kind of results the company can submit in the next two quarters; the leverage is certainly there to take modest gains in RevPAR and turn it into strong net earnings growth. One or two solid quarters of improvement, and the forward P/E should drop back to the high-teens, a better entry point for top-flight operators like Marriott and Starwood, both of which have a good mix of mid-scale & up-scale properties. (For some tips on travel, check out Top 9 Vacation Destinations For Wall Street Geeks.)